Investments to Help Beat Inflation

Quinlyn Manfull
August 16, 2022

While July saw a slight pullback from the 9.1% Consumer Price Index (CPI) level we saw in June, the July figure of 8.5% annual inflation is still far above the Federal Reserve’s target inflation rate of 2.0%. Based on expert predictions, investors and borrowers should anticipate more interest rate hikes through the rest of the year.

When inflation erodes purchasing power and savings accounts’ monetary value, the challenge is finding investments that can help to still generate real returns.

What to Expect During Inflation

The Fed has a target rate of inflation of 2%, as the general trend of prices rising over time is expected. When price levels rise quicker than 2% a year, consumers and investors can face difficulties as their purchasing power falls rapidly.

Should Inflation Change Your Investment Strategy?

Most financial advisors tend to recommend keeping the same investment strategy even as markets get volatile, as is common to see in the face of high inflation. This means that your long-term goals, allocation, and risk tolerance shouldn’t go out the window because of market changes.

Different asset classes and industries react differently to inflation. Being aware of these assets can be useful for determining how to respond to inflation. 

Investments To Help Beat Inflation

Equities

Stocks generally offer a reliable haven during periods of high inflation because stocks historically produce total returns that exceed the rate of inflation. Many companies are able to pass along the burden of higher prices to their consumers by raising prices, while other companies are far less dependent on the cost of raw materials to maintain their profit margins.

For 2022, equities of small-cap, dividend growth, consumer products, financial, energy, and emerging markets companies are showing up on multiple recommend lists including Goldman Sachs, Citi Bank, and Morningstar.

A diversified investment portfolio can provide a measure of protection from any market movement from inflation to a recession, by spreading investments across different sectors and asset classes that react differently to different market conditions.

Picking individual stocks can be research intensive and can still carry high risk. Investors interested in investing in equities can easily diversify by investing in an S&P 500 index fund or an index-based ETF, which tracks an index’s return and keep costs lower for investors. These funds contain hundreds of stocks, meaning they provide simple, low-cost diversification to reduce risk and make portfolio management much simpler.

Warren Buffett said during a 2015 shareholding meeting “the best businesses during inflation are the businesses that you buy once and then you don’t have to keep making capital investments subsequently.” In this meeting, he highlighted real estate while saying that businesses with heavy capital investments such as utilities are not good investments during inflation.

Real Estate

Real estate is one of the most common inflation hedges. Residential real estate particularly is viewed as a haven for 2022. Real estate investment trusts (REITs) offer a way to invest in real estate without personally purchasing properties. The MSCI US REIT Index has an average annual return of more than 10%.

An MIT economics analysis found that retail property has proven to be the best category of real estate to beat inflation, while apartment buildings and industrial properties were not as successful (while still providing inflation protection). Real estate is a common inflation hedge both because rental prices tend to reflect inflation rises, and because they provide a consistent income stream from rents.

For an individual investor, owning your own home can be a useful inflation hedge both because of the rise in value, but also because rent prices have been some of the quickest climbing prices in the current inflationary period. According to the Federal Housing Finance Agency, home values have seen a 4% average annual growth since 1991.

Contemporary Art

Contemporary art, like many collectibles, is a popular investment during periods of high inflation because it’s seen as a store of value and for its historic stability. Collectibles differ from other asset classes because they have no intrinsic value, their value is determined by how much individuals are willing to pay for them. Art is also an asset with a low correlation to the stock market, meaning it is generally shielded from market volatility.

Using Masterworks data, it was found that between 1973 and 1981, when inflation in the US was running around 9% annually, the art market outpaced equities and even gold. During that time, gold averaged an annualized growth of 31.1% while the art market had an average annual appreciation of 33.2%.

Treasury Inflation-Protected Securities (TIPS)

One asset that is designed specifically to protect against higher prices is Treasury inflation-protected securities (TIPS). The US Treasury sells TIPS and adjusts their par value each year to keep up with the CPI. These adjustments grow interest payments and ensure investors see some level of appreciation from inflation-adjusted investments.

While TIPS are a great inflation hedge, they do not necessarily provide growth as their goal is simply to preserve purchasing power. From 2012 to 2022, the iShares TIPS Bond ETF, which tracks a TIPS index, returned an average annual return of just over 3%.

The price of TIPS rose sharply along with the inflation outlook in late 2021, so these may not be as attractive as they were a year ago, but if an investor believes inflation will continue to stay far above the target range, they still may be a reliable choice.

Savings Bonds

Savings bonds, or I bonds, are another Treasury-issued security designed to beat inflation. Like TIPS, savings bonds preserve purchasing power by making regular interest adjustments based on current inflation. But unlike TIPS, the par value of the bond does not change, instead, they change interest rates every six months.

Savings bonds are typically considered safe investments because the value can’t decline, which makes them a stable investment during inflation or any other period of economic uncertainty.

Commodities

Raw materials and agricultural products tend to outperform the market in times of inflation because of their intrinsic value and their importance in the supply chain. Practically all processed goods rely on a variety of different commodities, so as the final price of goods rises, the price of inputted goods is likely to have already risen or will rise soon. Research by Vanguard found that over the last decade, commodities rose by 7-9% for every 1% of unexpected inflation (the difference between projected and realized inflation).

Gold, precious metals, and other commodities can be purchased indirectly by investing in a mutual fund or exchange-traded fund (ETF) that owns the commodities.

Short-term Bonds

Investing in short-term bonds is a similar strategy to maintaining cash in a high-yield savings account or CD. Not only do these vehicles keep up with inflation, but they provide increased liquidity as your money is quickly accessible.

If the Fed raises interest rates in response to rising inflation, short-term bonds are more resilient than long-term bonds.

Bottom Line

There is no one-size-fits-all approach to investing in an inflationary environment, as each investor’s goals, time horizon, and risk profile is going to be different. The investments covered above are not the only inflation hedges available to investors, and each investment strategy is going to differ.

Investors should be aware of inflation’s impact on their portfolios while being mindful that inflation isn’t the only variable at play in the markets. Taking a holistic approach to portfolio construction that accounts for a variety of potential risks is often the best choice.

This material is provided for informational and educational purposes only.  It is not intended to be investment advice and should not be relied on to form the basis of an investment decision.


Quinlyn Manfull
Quinlyn Manfull is a a New York based finance writer covering alternative investments, crypto, and NFTs. Previously she worked as an Investment Analyst for HSBC Private Bank covering capital markets. Her byline has been featured in the Anchorage Daily News, and her university newspaper, The Willamette Collegian. Quinlyn earned a B.A. in Economics from Willamette University and holds her FINRA Series 7 License.